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Last week, we upgraded Chinese Stocks (MCHI) to a Buy rating of 7 from Neutral. After a weak 2023, we believe the stocks are now offering a very asymmetric opportunity in 2024:
- The stock market bailout package of $278bn could finally be catalyst that helps turn the corner in restoring confidence in the Chinese economy and stocks
- Valuations of Chinese companies are so cheap that even just a bit of good news could lead to a huge rebound without taking a massive amount of risk
That catalyst is putting China’s growth stocks back onto the spotlight given attractive valuations:
- Their forward-P/E ratios looked very similar to those of their U.S. counterparts right up to 2022, when investors became worried about China’s harsh lockdown policies
- Those worries raised the level of uncertainty of Chinese stocks, crushing their valuations
- China’s growth stocks are being valued at a forward-P/E of 15x compared to 29x for their U.S. equivalents, a nearly 50% discount
Some of China’s “crown jewels” offer very comparable fundamentals to their U.S. counterparts, while trading at much lower valuations. Social media platform Tencent (TCEHY) is one example:
- It’s a social media platform offering e-ecommerce, mobile gaming, payments, AI and other services in a similar manner to Meta (i.e., Facebook)
- But Tencent is a much more profitable firm, with an operating margin of about 40% compared to Meta’s 29%
- It’s growing revenue a bit slower than Meta, but a recovery in economic growth in China would see earnings expand quickly given high margins and a rebound in sales
- Tencent is trading at a 36% discount to Meta based on forward-P/E ratios
We’re not making specific bets on Chinese growth stocks like Tencent, but on MCHI, which is a diversified ETF. However, the stock does account for a hefty 14% of its weight as its top holding.
While we’re optimistic on Chinese stocks, we’re also cognizant that the recent rebound could prove premature:
- A stock market bailout isn’t a sustainable fix for China’s economic problems
- To risk-manage this highly contrarian trade, our stop-loss is set at the key support level of $35
Separately, in the TLT section of today’s asset ratings article we highlight key risks to our long TLT trade heading into this week’s Fed meeting and Treasury supply announcement.
A few developments took place since our last ratings post:
- Upgraded GDX to a Strong Long rating of 8 from a 7 in a Flash Update last week, as the GDX/S&P 500 was at key support
- Upgraded MCHI to a 7 from a Neutral stance in a Flash Update last week given the stock market support package reported by news outlets as a potential inflection point
- Upgrading XLU to a Long rating of 6 given the XLU/S&P 500 trading at multi-year support and very attractive valuations of Utilities stocks
- Downgraded the S&P 500 to a Short rating of 4 from Neutral as documented in last week’s S&P 500 Memo
- Moved Bitcoin to a Neutral stance from a Short rating of 4 as we book profits from the short trade, as documented in a Flash update last week
Lastly, we’re changing the ratings categories from Sell to Short, and from Buy to Long to be more clear as to the actionability of the Asset Ratings more clear.
Ratings:
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Chinese Stocks (MCHI ETF)
Rating = Long (7)
- In a Flash Update last week, we upgraded MCHI to a Long rating of 7 from a Neutral stance.
- The upgrade was driven by the $278bn stock market support package announced by news outlets, amid very attractive valuations. Please refer to the Flash Update for more details.
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Utilities Stocks (XLU ETF)
Rating = Long (6)
- We’re upgrading XLU to a Long rating of 6 given that the XLU/S&P 500 ratio closed last week at critical support on a weekly basis, with a long wick candle (a bullish development).
- While we had just recently downgraded XLU to Neutral on the back of a breakdown of the monthly XLU/S&P 500 chart, we’re putting more weight on the weekly version of the chart.
- That’s because in the weekly version, the reactions we saw in the last few years marked the start of episodes when the market began to worry about a potential recession: a trade war amid Fed tightening in early-2018 and Fed hikes in early-2022.
- If price were to trade below the close of last week’s XLU/S&P 500 candle ($59.86), we’d likely move XLU to a Neutral stance and await a better entry opportunity.
- As we’ve mentioned in our recent work, Utilities stocks are trading at very attractive valuations. We believe the reward-to-risk is very opportunistic today to add defensive stocks as a cheap hedge on a recession materializing later this year as we expect.
Uranium Miners (URA ETF)
Rating = Neutral (5)
- URA is back in the price channel following surge in volatility. In recent weeks, URA had seen a big drop triggered by the ETF manager selling holdings to meet dividend payouts and a subsequent jump due to news around a supply shortage from a top producer.
- After investors digested the recent developments, we see that not much has changed and price is now back in the channel facing key resistance. As a result, we maintain the Neutral stance we had before the most recent whipsaws.
- Uranium spot prices (as proxied by the Sprott Physical Uranium Trust) are being rejected around channel resistance, after a significant run-up in recent weeks left them overextended.
- We’re working on an Investment Radar article updating our view on uranium that will be posted this week.
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S&P 500 Index
Rating = Short (4)
- We downgraded the S&P 500 to a Short rating of 4 given a series of vulnerabilities that included trading at key channel support and VIX divergence, among others.
- We’d been in a Neutral stance for a few weeks, waiting for the opportune time to short the market. We expect a tactical pullback in equities in January and February.
- The full rationale for the downgrade was documented in last week’s S&P 500 Memo. Please refer to it for more details.
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Energy Stocks (XLE ETF)
Rating = Short (3)
- In a recent Flash Update, we began a short position on XLE given the breakdown in weekly trendline support, as well as the activation of a head-and-shoulders pattern in the XLE/S&P 500 ratio. We expect significant downside to energy stocks in coming weeks.
- XLE is now re-testing trendline support on a weekly basis, as oil prices have moved higher on the back of geopolitical risks that has disruption of transit of oil tankers in the Red Sea.
- The daily chart is showing XLE rebounding off price channel support that also coincided with trendline support. Price may move to the top of the channel before reversing.
- We’d likely downgrade our rating further, to a 2 or lower, on an approach to the top of the channel given what would be an improved reward-to-risk ratio.
- As a result, we’re moving our stop-loss from $85.50 to the top of the price channel to avoid getting whipsawed. We’d likely revert to a Neutral stance if price were to break above it.
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Treasury Bonds (TLT ETF)
Rating = Strong Long (9)
- We recently upgraded TLT to a Strong Long rating of 9 from an 8, adding on weakness while price was trading at key support and our view of recession materializing later this year.
- However, next week poses some upside risks to Treasury yields with the Fed meeting, and also the Treasury Quarterly Refunding Announcement.
- One potential issue for bond bulls is that the Fed reiterates less urgency to cut interest rates given that the labor market isn’t showing obvious signs of deteriorating.
- Another worry this week is that the Treasury could announce a bigger volume of Treasury issuance than the market is expecting in their Quarterly Refunding Announcement, like what happened at the end of July that propelled long-term rates higher.
- There’s a potential head and shoulders pattern that suggests a target for TLT of $86 if it were to get activated. We’ll keep you updated on this development.
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Oil
Rating = Short (4)
- Oil prices staged a comeback last week, breaking through downtrend resistance we’d been monitoring in previous reports. That threatens our bearish view, at least in the near-term.
- The gains may be related to geopolitical risks related to disruption of oil tanker traffic in the Red Sea, as well positive news flow out of China as copper prices have also moved higher.
- In the medium-term, however, momentum still looks weak, with price still trading below key moving averages, which could act as strong resistance for oil.
- However, to avoid the risk of whipsaws in a volatile asset like oil, we’re moving our stop-loss to $83 that provides a bit more room for some of these recent idiosyncratic risks to play out.
- We expect significant downside in oil prices this year given our view of a recession materializing in the second-half and amid rising oil production.
Gold (GLD ETF)
Rating = Long (7)
- GLD’s momentum weakened after our recent upgrade. Price is struggling to clear the May 2023 highs and it’s broken down trendline support, the 50-DMA and our initial stop-loss at $187.50.
- The issue has been dollar strength and rising real interest rates. Geopolitical risks haven’t escalated enough to offset those macro headwinds.
- The S&P 500/Gold ratio is now at critical resistance, which doesn’t make for an objective time to downgrade GLD as prior reactions saw stocks significantly underperform gold.
- This technical development is coinciding with the potential for renewed optimism on China, which if it has legs could lead the dollar to inflect lower to the benefit of precious metals.
- Real rates will also play a role, and next week’s Fed meeting and Treasury quarterly refunding announcement could prove critical for precious metals.
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Silver (SLV ETF)
Rating = Long (7)
- SLV is re-testing downtrend resistance that’s been a struggle to clear since December. Price is hovering close to our stop-loss of $20.55. To avoid whipsaws, we’re moving it to the uptrend support line that’s captured the rebound in SLV since September of 2022.
- If price were to drop and re-test uptrend support, we’d likely upgrade SLV to a Strong Long of 8 or 9 given the improved reward-to-risk setup and our bullish view on precious metals.
- The aggressive breakout in the Gold/Silver ratio that we highlighted a couple of weeks ago has reversed back into the channel. The false breakdown looks bullish for silver and precious metals.
- The dollar remains a threat for our precious metals positions, as the DXY is bouncing off key support. Renewed optimism in China would likely weaken the dollar to the benefit of silver.
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Ethereum
Rating = Strong Long (8)
- Ethereum is a calculated bet on a Fed pivot that has significant upside if a recession doesn’t materialize and less downside than stocks or Bitcoin, which look very overextended.
- On the other hand, Ethereum has substantial upside to rise to the top of a price channel, while trading near support and close to its moving averages.
- Ethereum is trading right below our $2,370 stop-loss. We’ll be monitoring the price action this week for a potential ratings downgrade.
- The Bitcoin ETF approval ended up being a “sell the news” event as we expected. Bitcoin sold off by 15% following the approval, while Ethereum only lost 1.6% better given that it wasn’t overextended going into the event as Bitcoin was.
- We may see a rebound in Ethereum as price is now at the bottom of the channel. The ETH/BTC ratio being close to support also indicates that the odds favor Ethereum outperforming Bitcoin in coming weeks.
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Bitcoin
Rating = Neutral (5)
- We moved Bitcoin back to Neutral as we book an 11% profit from our short trade following the Bitcoin ETF approval. That ended up being a “sell the news” event for Bitcoin as we expected, with the cryptocurrency losing 15% of its value since then.
- We’re reverting Bitcoin’s rating back to a Neutral stance. We had high conviction that Bitcoin would get rejected off resistance following the ETF approval. With the bulk of the trade done, we want to book profits in this very volatile asset.
- Despite the big decline in Bitcoin following the ETF approval, we prefer Ethereum for our crypto exposure. As we’ve shown in the last several Weekly Asset Ratings reports, Bitcoin market dominance remains near a top, leaving little runway for Bitcoin to gain relative to other coins.